Remember The Yen Carry Trade?

The yen carry trade caused some anxious moments a few months back when the fear of players unwinding their trades took centrestage. That died down and investors continued to borrow in yen to invest in other higher yielding currencies, stocks or bonds. Just like Britney Spears, oops, I did it again... the sustained but managed weakness in USD has basically unraveled the yen carry trades. The current equity weakness globally is merely a result of yen carry trades unwinding. The stronger the yen, the worse off will be the investors who borrowed in yen to buy Aussie bonds, Singapore REITs, US stocks, Malaysian plantations, HK-H shares, etc...

While we were sleeping, the USD has breached the 110 yen level. The yen's strength is not the only one. The euro has also moved from strength to strength against the greenback hitting record highs after expectations of a further interest rate cut at the next Federal Reserve policy meeting. Further euro support came in the form of comments from a senior Chinese political figure, who said that China should diversify its US$1.43tn foreign exchange reserves by buying more strong currencies like the euro.

Ben Bernanke told US lawmakers that the Fed expects economic growth to slow in the fourth quarter of 2007 and the first half of 2008. Further dollar depressing news came in the form of US consumer sentiment data, which fell to 75.0 in November, hitting its lowest level in two years. On the other hand, the European Commission said eurozone economic growth this year will be slightly better than expected, however, financial market turbulence is seen slowing growth in 2008 and 2009. Markets largely ignored comments from US Treasury Secretary Henry Paulson, who defended the dollar’s status as the world’s reserve currency.

The yen has appreciated against a basket of currencies and not just the USD, but the effect was more pronounced with the greenback. The yen also found support from comments by Bank of Japan Governor Toshihiko Fukui, who underlined the need to increase interest rates in a timely manner. The greenback made some small recovery against the yen on news that the US trade deficit unexpectedly narrowed in September on strong export growth. However this was short lived as the yen soon hit a 1 ½ year high against the dollar on the back of fears of wider credit related losses in US financial firms which resulted in speculators unwinding carry trades.

Now it looks likely that high yielding currencies such as the AUD, Canadian loonie, NZD and Thai baht should see an exodus of hot money due to carry trades, and weaken a bit from here.